The hegemony of the main hard currencies – the dollar, the pound, the euro and the yen – as trade invoicing currencies is well known. In particular, regardless of origin and destination, countries’ exports and imports tend to be denominated in these currencies, led by the US dollar. There is therefore a significant asymmetry in international trade, where countries often invoice their exchanges in a vehicle currency which is neither the currency of the exporter nor that of the importer.
In this context, the Reserve Bank of India’s July 11, 2022 notification has attracted wide attention. The notification, titled “Indian Rupees (INR) International Trade Regulations”, allowed cross-border trade in Indian currency under the Foreign Exchange Management Act 1999 (FEMA).
Under this agreement, the RBI sets out the rules that allow Indian exports and imports to be denominated and invoiced in INR, using bilateral market-determined exchange rates. What was the trigger for such a measure? Was he motivated by the current payment chaos created by the Russian sanctions? Or are there strategic considerations?
A rupee-denominated trade arrangement is not new to India. From the 1970s until around the early 1990s, India had similar bilateral agreements with the former USSR and some Eastern European countries; the only significant difference being that these exchanges were previously done using bilaterally agreed fixed exchange rates.
Since 1991, when India adopted a flexible exchange rate regime and attained current account convertibility status in 1994, it has gradually moved away from this rupee-denominated international trade.
What is India’s trade currency basket? Currently, India’s international trade is mainly denominated in dollars and euros. A database published by the International Monetary Fund in 2020 shows that in 1992, 20.4% of Indian exports were invoiced in INR, in 2000 this figure was only 0.3% ( www.imf.org/-/media/Files/Publications/WP/2020/Datasets/wp20126. ashx).
The dollar dominates
In 2014, the latest year for which such data is available for India, the shares of the dollar and the euro in India’s export basket were 86.8% and 7.7%, respectively. Exports invoiced in all other foreign currencies were only 5.5 percent. According to this database, since 2005, India has not reported any exports denominated in rupees. It should be noted that while in 2014, 86.8% of Indian exports were denominated in dollars, the United States accounted for only about 13% of Indian exports during the same period.
This disproportionate use of the dollar stems from the USD’s unique position in international trade and commerce. It is likely that the use of a vehicle currency is often preferred as a medium of exchange because it reduces transaction and coordination costs for exporters and importers. The stability of vehicle money in terms of inflation, volatility and liquidity are important factors that propagate the uses of vehicle money as a more stable unit of account.
Finally, as vehicle currencies are likely to have deeper markets and are more widely accepted, economic agents involved in international trade may prefer these currencies as the best store of value. Therefore, the dollar has overwhelming dominance in international trade and commerce.
The dollar’s share as an invoicing currency is estimated to be about 3.1 times its share in world exports. Given this dominance of the dollar in international trade, have recent geopolitical developments prompted the RBI to introduce rupee-denominated trade? The Russian-Ukrainian conflict has led to widespread sanctions against Russia’s central bank and its international business dealings. Several Russian banks are also excluded from the Swift financial messaging system. On the other hand, India, a major oil-importing country, is suffering the triple blow of rising oil prices, massive outflows of foreign capital and the appreciation of the US dollar.
In this context, rupee-denominated trade can be a win-win for India and Russia, as India will be able to import cheaper Russian oil, possibly circumventing some of the restrictions of Western financial mechanisms. This will allow Russia to import certain essential products, such as pharmaceuticals, from India.
Indian and Russian exporters will benefit from better market access in the partner country. Similar mutual benefits can also be explored with a few other countries like Iran, which may not prefer to use carrier currencies like USD in international trade.
It should be noted that trade invoiced in rupees between India and a partner country does not have to be balanced. In case the trade is not balanced, the RBI has allowed the excess funds to be invested in the Indian capital market. These investments may be repatriated, subject to capital account regulations.
Admittedly, the RBI’s rupee-bill trade deal is not specific to Russia or oil. Since several countries in South Asia are facing financial problems and foreign exchange constraints, a rupee-denominated international trade framework can also be useful for these countries. By way of illustration, India has promised a line of credit of several billion dollars to Sri Lanka.
From a more medium to longer term perspective, this could allow India to move away slightly from the use of a carrier currency in regional trade. With the right kind of logistics and diplomatic support, this could pave the way for the creation of a rupee-dominated currency bloc in South Asia. While at this point the internationalization of the rupee is well beyond the immediate horizon, the regionalization of the rupee may be a step in that direction.
However, there are complications. There may be unease among U.S. policymakers about countries moving away from dollar-billed trade and thereby circumventing their sanctions on Russia and some other countries. There are reports that Russia is increasingly requiring trade to be denominated in dirhams. The endgame will therefore be political and diplomatic. Although India should proceed with caution, these measures could address both immediate concerns and strategic considerations.
Pal is Professor of Economics at IIM Calcutta and Ray is Director of the National Institute of Banking Management in Pune. Views are personal
July 24, 2022